Exhibit 2 presents the annual production possibilities schedules for two typical farmers—one in California, the other in Kansas. Currently, the California farmer is producing 200 bushels of oranges and 600 bushels of wheat. The Kansas farmer is producing 100 and 400 bushels of oranges and wheat, respectively. Thus, the total output of the two farmers is 300 oranges and 1000 wheat. a. The California farmer is able to produce more oranges and wheat than his Kansas counterpart. He has an absolute advantage in the production of both goods. Would gains from trade be possible? (Ignore transportation costs.) b. Suppose both want to consume their initial amounts of wheat—600 for the Californian and 400 for the Kansan. The Kansan decides to specialize in wheat production (800 bushels). Setting aside 400 bushels of wheat for himself, he offers to trade 400 bushels of wheat to the Californian for 150 bushels of oranges. Would the Kansan gain from this transaction? Could the Californian gain if he increased his orange production to 400 and then traded the 150 bushels of oranges to the Kansan for the 400 bushels of wheat? What has happened to total output? c. Explain why gains from trade are possible, even though the Californian has an absolute advantage in the production of both goods.
Exhibit 2 presents the annual production possibilities schedules for two typical farmers—one in California, the other in Kansas. Currently, the California farmer is producing 200 bushels of oranges and 600 bushels of wheat. The Kansas farmer is producing 100 and 400 bushels of oranges and wheat, respectively. Thus, the total output of the two farmers is 300 oranges and 1000 wheat.
a. The California farmer is able to produce more oranges and wheat than his Kansas counterpart. He has an absolute advantage in the production of both goods. Would gains from trade be possible? (Ignore transportation costs.)
b. Suppose both want to consume their initial amounts of wheat—600 for the Californian and 400 for the Kansan. The Kansan decides to specialize in wheat production (800 bushels). Setting aside 400 bushels of wheat for himself, he offers to trade 400 bushels of wheat to the Californian for 150 bushels of oranges. Would the Kansan gain from this transaction? Could the Californian gain if he increased his orange production to 400 and then traded the 150 bushels of oranges to the Kansan for the 400 bushels of wheat? What has happened to total output?
c. Explain why gains from trade are possible, even though the Californian has an absolute advantage in the production of both goods.
Gains from trade refer to the net economic benefits that arise when two economies participate in free and voluntary trade with each other. An economy engages in exchange by specializing in the production of goods and services in which it has a comparative advantage according to the law of comparative advantage given by David Ricardo.
Gains from trade are possible as even though the California farmer has an absolute advantage in the production of both commodities, the opportunity cost of producing one commodity is different for both farmers.
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